The Federal Reserve is the $7tn gorilla in the financial markets, and investors wish it was willing to throw its weight around a bit more.
The US central bank showed little hesitation in wading into the market during the pandemic panic in March, and investors took comfort from knowing that the Fed and its chairman Jay Powell had their back, but they found his reluctance this week to promise more specific action quite frustrating.
Equities sold off sharply during his press conference on Wednesday, and again on Thursday. Although the Fed promised it would not raise interest rates until inflation had outstripped its 2 per cent target — years away, even if it is lucky — no new guidance came on how it might adapt its balance sheet policy to generate that inflation and aid the US economic recovery.
“That was something the market was hoping to get more clarity on and they failed to deliver it,” said Michael Kushma, chief investment officer of global fixed income at Morgan Stanley Investment Management.
The March turbulence prompted the Fed to begin a programme of unlimited asset purchases and to set up 11 lending facilities to shore up a broad swath of hard-hit debt markets. What resulted was an unprecedented expansion of its balance sheet. Between March and early June, it ballooned from roughly $4tn to a peak of just over $7tn. But since then, its growth has stalled.
The Fed’s bond-buying programme currently involves purchasing $80bn of Treasury securities per month and $40bn of agency mortgage-backed securities. Having decided last month to pursue a new monetary framework in which it allows inflation to run above its 2 per cent target, expectations were elevated for a broader rethink of that strategy.
While the Fed did reframe the purpose of its purchases — from strictly an issue of market functioning to one tied to supporting the economic recovery — Mr Powell did not signal an imminent adjustment either in the scope or scale of the programme.
One cohort of investors had believed it necessary for the Fed to shift the focus of its purchases specifically to long-dated Treasuries in order to ensure borrowing costs remained low, while another subset thought a larger programme was warranted.
“There was an inconsistency with the super-strong forward guidance on rates and quantitative-easing, which was a little more loosely defined,” said Mike Stritch, chief investment officer at BMO Wealth Management.
Krishna Guha, vice-chairman at Evercore ISI, called the Fed’s current approach to bond-buying “weak”, and urged the Fed to “deploy all its instruments”.
Mr Powell also faced questions about what many had hoped would be an important pillar of its coronavirus response so far: the Main Street Lending Program.
This is one of the 11 lending facilities rolled out since March under powers that allow the central bank to make asset purchases in “unusual and exigent circumstances”, but it differs from the sorts of programmes it has run in previous crises because it involves purchasing loans made by banks to small and medium-sized businesses — hence the “Main Street” name.
While usage has remained modest across all of the Fed’s facilities — a phenomenon investors largely attribute to the robust rebound in financial markets — the failure of the $600bn MSLP to gain traction has provoked concern because it suggests that companies which are the backbone of the US economy are not benefiting like their larger peers from the reopening of capital markets.
According to Financial Times calculations based on Fed data published on Thursday, just $93.8bn of the Fed’s balance sheet firepower is being deployed through the various emergency facilities. That is down from a high of $107bn in July and is less than 4 per cent of the minimum $2.6tn the central bank said it would make available.
For the MSLP, only $1.45bn has been lent out so far, or 0.2 per cent of its total capacity.
“For smaller corporations, survival is something that is a point of concern not only in terms of potential bankruptcies but also delinquencies as we go forward,” said Leslie Falconio, senior strategist at UBS Global Wealth Management.
Investors acknowledge that the Treasury department, which has provided a backstop for the MSLP, may also have to change its approach. Part of the reason for its limited use stems from the fact that the Treasury wants to “minimise losses”, said Ms Falconio.
On Wednesday, Mr Powell said the Fed may make further adjustments to the MSLP and will continue to work with banks to ensure they are on board to extend out credit.
“We also want them to take some risk, obviously, because that was the point of it,” Mr Powell said of the banks. “And the question is, how do you dial that in? It’s not an easy thing to do . . . We’re continuing to work to improve Main Street, to make it more broadly available.”
One of the reasons investors are itching for more from the Fed is that they are resigned to getting so little from Congress. Policymakers have been locked in a stand-off over a new stimulus package for months and now economists fear relief will not come until after the US election in November.
The extent of the additional support required by the Fed hinges largely on Congress, said Praveen Korapaty, chief global rates strategist at Goldman Sachs.
“So long as the fiscal authorities are being proactive, it takes pressure off the central bank to deliver something at every meeting,” he said. “They can’t always surprise the market to the upside”
Additional reporting by Brooke Fox
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